Some of our clients are looking at opportunities to do business abroad. Others have been doing it for quite some time. This brings opportunities, but certainly also challenges. Transfer pricing is currently one of the most important tax issues facing larger international entrepreneurs.
What is transfer pricing?
If you are a company of sufficient size operating in several countries, you are required to work with transfer pricing. What does that mean in practice and what should you know about it? Let’s start with what transfer pricing is. Transfer pricing is the concept of having to charge for products and services provided within the group of companies. The prices should be market-based amounts and should therefore be determined “at arms length.” This means that when you do business within your group, prices for transactions between your entities should be calculated based on terms that would also apply between independent parties.
Transfer pricing regulations
In recent years, there has been increasing In recent years, there has been an increasing amount of regulation on transfer pricing. The Organization of Developed Economies, the OESO, has developed guidelines to ensure that cross-border intra-group transactions are priced at arm’s length. The Netherlands has translated these guidelines into a Transfer Pricing Decree. These guidelines were recently, amended by the Dutch Ministry of Finance.
As mentioned, regulations are constantly changing. But you may be wondering why you need to consider transfer pricing within your group
Tax differences between countries
In intra-group transactions, the underlying transfer prices directly affect profits and thus taxation in the country where an entity is located. This is due to differences in tax burdens between countries or the use of losses in other countries. As a result, it can be tempting to artificially shift profits within your group.
As an example, let’s take a Dutch private company (a BV) that supplies semi-finished products “X” to its affiliated German company GmbH. How much should the BV charge for these products X? Especially if the BV only sells products X to the GmbH and not to any other third parties, how does it know that it is charging the right price for it? The GmbH has been making a loss for years, while the BV is making a profit. If product X is now sold at a low price, the BV’s profit will be lower, while the GmbH will have a higher result and thus make fewer losses.
The tax burden for the group is thus reduced. So let’s do it, you may think? That would however be very unwise. After all, the tax authorities in the Netherlands could claim that the price for half-product X is too low and impose a correction. Subsequently, it remains to be seen whether the tax authorities in Germany will follow this correction. If it does not, there will be double taxation.
Another risk is, for example, the charging of costs by a group’s head office. For tax purposes, it is then important to determine whether these are corporate services to be charged or shareholder costs to be borne by the head office itself.
Double taxation arises if the tax authority of the country of the head office regards the costs as intra-group services and the tax authority of the country of the subsidiary regards the costs as shareholder costs. In this case, the costs incurred cannot be deducted in any country. In short, plenty of reason to pay attention to transfer pricing.
Legal obligations and fines
Other reasons to take transfer pricing seriously are the legal obligations that groups have. For example, there are documentation requirements for groups whose total group revenue exceeds 50 million euros on an annual basis. There must then be a group file (master file) and several local files (local files).
This documentation gives tax authorities insight into the distribution of profits within the group and the transfer prices used. The documentation includes a description of the company’s activities, functions and risks. For groups with consolidated sales exceeding €750 million, there is also an annual Country-by-Country reporting requirement (CbC report).
Strict penalties apply in the Netherlands for failure to comply with transfer pricing administration requirements. Failure to prepare a master file, local file and a CbC report (if applicable) could lead to an administrative fine of up to € 870,000 as well as criminal penalties and a reversal of the burden of proof. Moreover, in the Transfer Pricing Decree, the State Secretary emphasizes that the tax authorities impose penalties when transfer pricing leads to improper shifting of profits. It is therefore wise to handle internal transactions carefully.
You understand from the above that it has therefore become increasingly important to pay close attention to transfer pricing in your group. The credo here: make sure the transfer pricing documentation is in order!